The World's Most Contrarian Investment?

What happens when you combine the global crash in telecom stocks with the near-depression aura that pervades the Japanese market? The Oxford Club’s CA Green tells us…you wind up with the world’s largest telecommunications firm.

John Templeton, perhaps the best known contrarian investor of all time, said it best: "Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria."

With this philosophy and a determination to look worldwide for investment opportunities, Templeton made a great fortune for shareholders of his flagship Templeton Growth Fund.

And he didn’t just outperform the market. He bludgeoned it – even during periods of lackluster growth.

Consider this: a $100,000 portfolio invested in the Dow in 1965 grew to only $107,973 by 1982. An identical investment in the Templeton Growth Fund grew to over $1.4 million over the same period.

John Templeton is a living rebuttal to modern portfolio theorists who claim financial markets are so efficient that simple indexing is your best strategy. (Or as Warren Buffet once remarked, "if markets were efficient, I’d be busing tables for a living.")

Templeton, who lives in the Bahamas and is still an active investor in his 80s, believes that the best values are always found at what he calls "the point of maximum pessimism." John Train, author of "Money Masters of Our Time", described him this way: "He insisted on buying only what was being thrown away." The reason: when popular sentiment is the most negative or, even better, apathy is the greatest, considerable bargains develop.

We’re at that stage now with an investment opportunity I’m about to share with you. And I’m not going to sugarcoat it: This is an unloved company, in a downtrodden sector, in the world’s single worst- performing major market. Most of Wall Street doesn’t cover it. And the analysts who do generally don’t like it. It’s not a cocktail-party story. It’s not a sexy stock.

But it has enormous upside potential. It’s a world class company by any standard. And, as you’ll soon see, it’s breathtakingly cheap.

What happens when you combine the global crash in telecom stocks with the near-depression aura that pervades the Japanese market? As it turns out, you wind up with the world’s largest telecommunications firm: Nippon Telephone & Telegraph.

NT&T is a Goliath. The company’s investments span the globe. And it’s the biggest provider of wireless and wireless voice, data, and internet services in Japan. It’s subsidiaries include behemoths like NTT Data and wireless leader NTT DoCoMo. Right now, NT&T has 52 million subscribers lines in Japan and over 36 million cell phone users.

Nippon is not only enormous, it’s enormously cheap. A few stats tell the tale. NT&T sells for only 2.8 times cash flow. The average stock in the S&P 500 sells for almost 19 times cash flow. NT&T sells at only 1.3 times book value. The average U.S. stock sells for almost 5 times book value. And NT&T sells for just 70% of last year’s revenues. The average company in the S&P 500 sells for more than 3 times last year’s revenues.

But NT&T isn’t just cheap. It’s changing for the better, providing a real catalyst for the share price.

Management is in the process of restructuring the company to increase operating efficiencies. And not a moment too soon. Last year, NT&T lost a record $6.7 billion when it overhauled its work force and wrote down investments overseas, including the $5.5 billion acquisition of U.S. web hosting firm Verio, Inc.

Now Nippon is set to deliver high double-digit earnings growth over the next two years. My research indicates that Nippon Telephone and Telegraph will earn over a dollar a share this year and increase those earnings another 28% in the following year. In fact, Nippon should easily compound its earnings at better than 24% annually over the next five years.

Some forward-looking investors are already beginning to realize this. A glance at the chart below shows that the stock has begun an upward trend in the teeth of a market sell-off both here and abroad.

Also a positive for NT&T is a new spirit of shareholder activism in Japan. In years past, shareholders deferred to management. And cross-shareholding agreements cemented business ties between companies. But those days are now ending. Management is becoming much more responsive to shareholder demands for bottom-line improvement. And the old boys club is giving way to fierce competition between companies. All to the good.

After discovering how cheap Nippon shares are, I investigated institutional shareholders to see if anyone else shared my conviction. I was gratified by what I found.

The biggest institutional shareholder of Nippon is none other than the best-performing international money management group in the world, Brandes Investment Partners. And they haven’t just flirted with the stock. They’ve gotten hitched. Their latest report shows that Brandes owns almost 29 million shares, or more than $600 million-worth.

Also on the plus side for us, shares of Nippon Telephone and Telegraph are yen-denominated. As the dollar continues its decline – as I’ve forecast all year – that will add to our total return in the stock.

Furthermore, Nippon Telephone & Telegraph is the bellwether stock on the Tokyo exchange. That means when serious institutional money begins flowing into Japan, NT&T will undoubtedly jump. NT&T represents the Tokyo market the way General Electric represents our domestic market.

Regards,

C. Alexander Green,for The Daily Reckoning
August 15, 2002

P.S. We have a world-class telecommunications firm, selling for 70% of its $100 billion annual revenues, that is set to deliver double-digit profits in the years ahead. This company will allow us to benefit from the ongoing erosion in the U.S. dollar and – despite widespread negativity and apathy – it gets a ringing endorsement from the best global money manager in the business.

Editor’s Note: Mr. CA Green, a fifteen-year Wall Street veteran, is Investment Director of The Oxford Club. In addition to writing on global investing for Wall Street Week’s Louis Rukeyser, he has been a writer or contributor to several financial publications including Global Insights, Short Alert, Insider Alert, Momentum Stock Alert, and the US edition of The Fleet Street Letter.

While stocks continued to bounce around yesterday, bonds did something interesting. The yield on 30-year treasuries dropped below 5% while the yield on 10-year notes fell nearer to 4% – a level not seen since the hula hoop.

It is not inflation that worries bond buyers today, it’s credit quality. For while the treasuries rose, bonds of UAL and other airlines fell off.

Gold, too, fell in price yesterday.

Mr. Market is signaling more recession and deflation ahead. Of course, Mr. Market and your editor here at the Daily Reckoning could be wrong.

"Alongside the deflationary economic downturn model, there exists an inflationary downturn model experienced frequently over the years in Latin America, which we label The Argentina Model (also known as Weimar Republic Model). The Argentina Model occurs when a central bank prints too much money (or monetizes too much government debt) and the currency collapses. This appears to be the policy option that Greenspan and the Fed have chosen."

MZM, a measure of the cash in the banking system, has been rising at a 12% annual rate. The Fed, we have little doubt, will continue trying to put as much cash and credit into the system as it thinks necessary to avoid a Japan-like deflation – even at the risk of following the ‘Argentina Model.’ That is why interest rates will go down.

But can the Fed succeed in destroying the dollar?

"Most American economists sleep well in the comforting belief that central banks are all-powerful in steering economies and markets," comments Dr. Kurt Richebacher. "If push comes to shove, they simply resort to printing money. In this vein, it has been a popular argument that the past bull market primarily resulted from the rampant money growth during these years engineered by the Fed. This is another shockingly naive and simplistic assumption."

We will see.

Eric, what’s the latest from Wall Street?

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Eric Fry, our man in Manhattan:

– It’s official…Mr. Market is certifiable! Yes, that’s right, yesterday was the deadline for America’s corporate chieftains to vouch for their companies’ financial statements. Most of them complied with the nonsensical request, and as a result, Mr. Market went certifiably crazy.

– Delirious trading carried the Dow 261 points higher to 8,743. The Nasdaq, meanwhile, seemed to take leave of its senses as it soared more than 5% to 1,334. Yesterday’s rally lifted the Nasdaq to its highest level since late July. Granted, the beleaguered index must rally another 46% to get back to breakeven for the year. But at least it’s bringing a few smiles to investors’ faces.

– As investors rushed into stocks, they rushed out of gold. The precious metal lost a little luster – falling $2.40 to $313.50 an ounce. Silver plummeted 12 cents to $4.46 an ounce.

– Now that the momentous "Certification Day" has come and gone, has Wall Street become a better place? Is it now safe for capital to stroll in the neighborhood of Wall and Broad without fear of being accosted?… Unlikely.

– There’s an old saying, "Figures don’t lie; liars figure." And we’d figure that the very same CEOs and CFOs who were cheating before August 14 will continue cheating after August 14. The methods by which they deceive shareholders, auditors and regulators may change, but the efforts to deceive will continue. Most deceptive CEOs don’t commit outright fraud, of course. They simply "shade the truth" in ways that enable them to grab a larger piece of the pie for themselves… Either way, the shareholder pays.

– When managing money as a professional short seller, I learned to ASSUME that management was lying, until proven otherwise. The game was to figure out exactly how they were lying.

– The infamous former short-seller, Matthew Feshbach, operated under the identical assumption, according to a recent interview with Kathryn Welling on her website. Matt was one third of the band of short-selling Feshbach brothers who thrived during the 1980s, before hitting a rough patch in the early 1990s. From 1983 through the end of 1990, he and his brothers produced a compound annualized return (net of fees) of more than 35%. Not too shabby. "But then, in 1991," he says, "we had a really rough year as the Nasdaq soared 55%." But clearly, Matt Feshbach learned a few things along the way.

– "There is nothing new in today’s environment other than who the criminals are," Feshbach tells Welling. He explains that he continues to believe what his father taught him, "Management always lies." Cynical? Yes. But a very helpful investment perspective, nonetheless.

– "I can’t say that I’ve changed my mind about management in general," he says. "I mean, look at the market today. People think that it is new news that Enron or WorldCom or somebody else made up the numbers. But what happened was only that the criminality floated up so pervasively into the bigger cap stocks…So to me, all the noise and outrage is sort of bemusing. I just know what people are like. So there’s nothing new in all of this." Buyer beware…still and forever.

– In another recent Welling interview, Baltimore’s own Jack Ciesielski, publisher of "The Analyst’s Accounting Observer," puts a price tag on the institutionalised corporate greed of the last few years. Within the S&P 500 companies, Ciesielski’s team calculates that the true cost of dispensing options to management and other employees in 2001 was nearly $47 billion, an increase of 30% from 2000. And yet, because companies almost never deduct this expense from their reported earnings, Ciesielski estimates that the S&P 500’s earnings in 2001 were overstated by a whopping 31%.

– "What’s more," Ciesielski tells Welling, "there were 19 companies last year [in the S&P 500]…that were able to report profits to shareholders ONLY because they didn’t have to expense the cost other option compensation…Stock compensation expense has grown at an average rate of 48% over the last three years, while earnings (ex-stock compensation expense) had declined an average rate of 15%."

– In other words, managements have been reaping an ever- larger share of an ever-shrinking harvest. Disgusting, isn’t it?

– But don’t worry, no one’s cooking the books anymore; the CEOs have told us so.

******

Back in Paris…

*** Actually, I’m not in Paris…but out in the country. This is a national holiday, which I am using to begin a 2-week vacation. I will continue writing up gratuitous reflections on the economy and the markets, but you, dear reader, will get a well-deserved break from my regular letters. Enjoy your vacation, too.

*** George II, Greenspan and Kudlow continue to remind us that the U.S. economy is fundamentally robust. They can’t imagine, or admit, that there might be something seriously wrong.

*** Count on Dr. Richebacher for a contrary opinion: "The recovery hopes are illusory," he writes. "The U.S. economy is in its worst shape in history, far worse than that of Japan, and far worse than it was at the beginning of the depression of the 1930s."

*** Dow companies imagine that they can manage their pension funds better than the world’s greatest investor. Warren Buffett’s Berkshire Hathaway projects earnings of only 6.5%. The average for the DJIA is 9.42%. How is it that the fund managers think they can do better than the Sage of Omaha?

*** We don’t know. But we note that last year American Express expected returns of 9.5% for its pension funds. It achieved minus 16.15%. United Technologies fantasized of getting a 9.6% return for its pension funds. It realized minus 17.77%. And Hewlett-Parkard thought 9% would be a reasonable return. Imagine how surprised it was when its pension funds lost more than 25% of their value.

*** Bonding with a 14-year-old is not always easy…even when you’re doing a mano y mano trip in the Third World. With the wonders of the pacific coast in front of him… the flora and fauna of Nicaragua all around him…and the language and culture of Latin America stretched out for hundreds of miles in every direction – Jules preferred to stay in his room watch American television.